SEC Probes Rapid Trading … Federal securities regulators are examining whether some sophisticated, rapid-fire trading firms have used their close links to computerized stock exchanges to gain an unfair advantage over other investors, people familiar with the matter say. The wide-ranging probe, being handled by the enforcement staff of the Securities and Exchange Commission, is focusing on the computer-driven trading platforms of exchanges, including BATS Global Markets Inc., the people said. The SEC probe illustrates a bigger push by regulators to examine less-transparent parts of the securities markets, such as the fast-growing area of so-called high-frequency trading. High- speed trading firms use powerful computer systems for rapid-fire trades, in which they often hold stocks for only fractions of seconds. They benefit by being able to move quicker than less technologically proficient investors. – Wall Street Journal

Dominant Social Theme: These crooks using computers are making it impossible for honest people to earn a living in the stock market.

Free-Market Analysis: As predicted in these modest pages, the US Securities and Exchange Commission is now taking aim at computers and trading. The proximate cause of the probe is the so-called Flash Crash in May 2010, when stocks fell hard and rose rapidly without an identifiable cause.

Some, especially in the alternative media, have speculated the Flash Crash was a warning sent by top traders on Wall Street to the US government. There have been other narratives floated as well.

The SEC has ALREADY investigated the Flash Crash itself and concluded in a 104-page report that a US$4 billion sale of stock index futures was the trigger for the sudden downturn. The seller was widely reported to have been Waddell & Reed, and the speed of the sell order supposedly aggravated market volatility considerably.

Is it surprising that the SEC should be revisiting the Flash Crash and using it as a springboard for a larger investigation of computerized trading? Those running the regulatory authority itself don't think so. They claim to be worried that fast-moving computerized trading gives top trading shops an unfair advantage over "other investors" – see article excerpt above.

The only trouble with this line of reasoning is that it posits a criterion that can never be fulfilled. It is impossible to make securities markets "fair" for all investors. And the idea that regulators can make them so is no more logical.

But with plenty of funding and teams of legal employees available to them, the top honchos apparently find further investigations of computerized trading irresistible. Here's some more from the article:

The SEC is examining, among other things, whether high-frequency firms benefit from delays in the dissemination of prices from various corners of the markets, according to a person familiar with the matter. High-speed firms use direct feeds from exchanges that can give them a leg up on slower traders, critics say. While most investors rely on feeds that consolidate prices throughout the market, high- frequency traders can access prices a split second faster through their access to direct feeds, experts say.

They do so through a practice known as "collocation," in which they place their trading computers in the same data center that houses the exchange's computer servers. The SEC also is examining fees that exchanges pay out to draw-in high-speed trading orders, according to the people familiar with the matter.

Firms that send orders to exchanges that help complete a trade are paid a small rebate, typically about 30 cents per hundred shares. Some high-frequency firms specialize in such trading, commonly known as rebate trading, which requires extremely fast connections to exchanges to achieve success and consistency.

Boiling this down is not hard. Several top trading boutiques have apparently found ways to gather securities prices more quickly than they are available to the general public. Traders at these shops can then purchase given securities at a lower price, knowing they will be able to sell them for slightly higher ones. Exchanges are willing to pay a fee to do business with these high-speed firms.

No doubt, the SEC will eventually issue "rules" that will reduce this "abusive" practice. But at this point the SEC and other financial regulators are like children sticking their hands in the dike.

Short of shutting down securities trading entirely and returning to fully physical, face-to-race trading, there is little regulators can do to realistically "level the playing field" between the "little guy" and the banking giants using computer power to gain advantages.

Some of the really sophisticated market manipulations are likely a combination of volume and computer trading. In even a moderately traded market various securities tend to trade in certain patterns. By anticipating those patterns, disrupting them and then re-buying the same instruments, one can effectively "front run" the market.

Such practices are rife and historical in nature as well. When the New York Stock Market wanted to merge with the Uptown Boys in the 1800s, NYSE honchos promised the Uptown Boys they could specialize in certain lucrative stock franchises. Thus the specialist system was born.

Top stock men and regulators have also perpetuated the idea that "market makers" are needed to "stabilize" and regularize securities prices. These market makers may be empowered by law to see more buy and sell orders than others – providing these individuals with a kind of regulatory mandated front-running.

Of course, these days there is plenty of speculation over Washington DC's so-called plunge protection team. This group, formed after the stock market crash of 1987, is still said to exist and regularly manipulates markets, especially the larger stock market, to ensure "price stability."

In truth, all securities markets must be penetrated by various kinds of market manipulation and corruption. These days, advantages accrue naturally to those with the most capital and the most computer power. This is surely an irresistible combination that likely guarantees success over time.

The SEC in particular is struggling desperately to stem the public perception that securities markets provide more benefits to the rich and powerful than to the average investor. The last time this perception was widespread, especially in the US, was in the 1930s and 1940s.

It took a world war and a subsequent 20-year campaign by the NYSE to woo investors back into the stock market. By the 1960s, stock markets were surging again. But the twin crashes of 2000 and 2007/8 have reignited in the body politic a healthy skepticism of securities trading and organized equity investing.

The great families of the power elite that control central banks around the world are determined to fight back against this skepticism. The artificial economy, so dependent on inflated paper dollars – monetary fiat – needs public acceptance for its continued existence.

The idea, then, is to ensure people participate in the equity markets, especially, so as to provide credibility for the larger economic system. Those who are making money, or feel they have the opportunity to make money, in various securities markets are less likely to be especially critical of the larger system.

It is a kind of elite sub dominant social theme, that stock markets in particular ought to be looked upon as fair and offering any investor, large or small, an equal chance at becoming a millionaire or more.

Yet surely the general public is more disenchanted with the current economic and investing system now than at any time since the 1940s. We believe that what we call the Internet Reformation – and a growing understanding of the Way the World Really Works – is contributing to this sentiment.

People are increasingly distrustful of various forms of organized authority and various mainstream nostrums when it comes to health and wealth. The stakes are very high for the powers-that-be, and this is one reason that the SEC continues to promote its high-profile investigations.

A major reason for the SEC's regulatory exercise is to illustrate clearly to the buying public that the markets are being properly supervised and investigated and that people have nothing to fear from participating.

After Thoughts

In fact, a combination of mathematical acuity, computer power and large-scale trading volume has created a growing disparity between big and small investors that will only increase over time.